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These Heavily Shorted Stocks May Break Higher

These stocks could be setting up for a major short squeeze.

Usually stocks that have a high percentage of shares held by short-sellers are a red flag. Though high short ratios are not a foolproof method of determining whether or not a stock is worth avoiding, they’ve served as the warning sign of a poor investment more often than not.

Company

Short Interest as % of Float

China MediaExpress Holdings(Nasdaq: CCME)

64.5%

Meru Networks(Nasdaq: MERU)

30.8%

Conn's(Nasdaq: CONN)

29.1%

Source: The Wall Street Journal.

Shares of China MediaExpress have been halted for nearly a month now following allegations that the company misstated its revenue and earnings figures. Conn’s reported fourth-quarter results last week which badly missed the mark and have the electronics retailer's stock down almost 30% over the past year. Likewise, Meru Networks shares have lost nearly one-quarter of their value in the past week after the wireless products and services provider significantly lowered its first-quarter guidance.

The lesson is that high-short ratios often tell us a convincing story -- but not in all cases. In fact, there are three companies which could bite shorts in the bottom if they aren’t careful.

Company

Short Interest as % of Float

Bridgepoint Education(NYSE: BPI)

58.8%

ATP Oil & Gas(Nasdaq: ATPG)

37.6%

SunPower(Nasdaq: SPWRA)

27.9%

Source: The Wall Street Journal.

Bridgepoint Education garners one of the highest short ratios in the entire market, but a quick glance at its balance sheet has me wondering why. As fellow Fool Andy Louis-Charles points out, Bridgepoint has expanded its student enrollment while also significantly padding its margins -- all while the entire education sector comes under heavy scrutiny by the Congress and the Department of Education. Short-sellers may have incorrectly bet against the wrong horse in this sector.

ATP Oil & Gas had its short interest spike through the roof during the BP oil crisis one year ago, which put a six-month moratorium on all deepwater drilling. Now clear of that crisis and with deepwater permits carefully being reassigned, prospects for ATP are looking up. Personally I like ATP for its undervalued natural gas reserves, but it's ATP’s potential oil fields that have most investors excited. If ATP does manage to strike it big in the Gulf of Mexico or off the coast of Israel, short-sellers could really be in a bind.

SunPower, a company that designs and sells solar electric panels -- and is a favorite of our socially responsible investing Fool Alyce Lomax -- simply appears too inexpensive to have attracted such a high short concentration. Short-sellers were lured by a potential slowdown in business from Germany, but based on SunPower’s most recent quarterly filing, they’ve been wrong to focus solely on Europe. Business in the U.S., as well as the potential need for substantially higher solar outputs in Asia helped move the company well past consensus estimates. Short-sellers may want to re-think their position in SunPower.

It remains to be seen if these three companies can squeeze shorts out of their positions. But based on their balance sheets and growth prospects, if I were short these three, I’d be shaking in my boots.

What’s your take on the companies mentioned here? Are you buying into these heavily shorted companies? Share your thoughts in the comments section below and consider adding these stocks and your own personalized list of companies to My Watchlist.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. He would like to remind you not to forget about our friends in Japan who could use a helping hand. You can follow him on CAPS under the screen name TMFUltraLong.Motley Fool Optionshas recommended a call spread position on Bridgepoint Education, of which the Fool owns shares.Try any of our Foolish newsletter servicesfree for 30 days.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policythat never needs to be sold short.

Author

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and investment planning. You'll often find him writing about Obamacare, marijuana, drug and device development, Social Security, taxes, retirement issues and general macroeconomic topics of interest. Follow @TMFUltraLong